TRUST AS A BENEFICIARY OF AN IRA?

Transcription

1 TRUST AS A BENEFICIARY OF AN IRA? BRADLEY J. FRIGON, JD, LLM, CELA CERTIFIED ELDER LAW ATTORNEY 6500 S. QUEBEC ST., STE. 330 ENGLEWOOD, CO (720)

2 TABLE OF CONTENTS I. INTRODUCTION... 4 II. RETIREMENT PLAN BASICS - HOW TO TALK THE TALK... 4 A. What are Retirement Assets?... 4 B. Retirement Assets Are Income in Respect to a Decedent... 4 C. Required Beginning Date (RBD)... 5 D. Required Minium Distributions (RMDs)... 5 E. Distributions at Death F. Inherited IRA -Death Before Required Beginning Date Spouse as Designated Beneficiary Non Spouse Designated Beneficiary G. Inherited IRA- Death After the Required Beginning Date Spouse as Designated Beneficiary Non Spouse Designated Beneficiary... 7 H. No Designated Beneficiary... 8 I. Five-Year Rule... 8 J. Multiple Beneficiaries..8 K. Titling an Inherited IRA. 9 L. Clark v. Rameker 9 III. NAMING A TRUST AS A BENEFICIARY OF A RETIREMENT ACCOUNT A. Determination Date 11 B. Conduit Trusts C. Accumulation Trusts Power to Appoint to "issue" Power to Appoint to a Charity 13 IV. TRUST PLANNING CHOICES FOR BENEFICIARIES A. Accumulation Trust 14 B. Charitable Remainder Trust Planning C. Disclaimers of Retirement Benefits D. Decanting E. Reformation..20

3 V. First Party (D)(4)(A) Trusts and Inherited IRAs A. Private Letter Ruling Private Letter Ruling 1: Transfer of IRA to Trust Private Letter Ruling 2: Life Expectancy for Annual Distributions Key Facts in this Case What You should take away from Private Letter Ruling B. Private Letter Ruling C. Private Letter Ruling D. Retirement Accounts, Payback Claim, and Taxes... 27

4 I. INTRODUCTION As lawyers doing special needs trusts planning, the majority of our attention is directed at securing or protecting our client s eligibility for public benefits and providing for their special needs. Retirement plans can be a useful tool in achieving these goals, but only if a thorough analysis of the applicable rules is undertaken to ensure that the outcome is the one that is intended. This article will review the applicable retirement plan rules and how they work with third party and first party special needs trusts. II. RETIREMENT PLAN BASICS - HOW TO TALK THE TALK A. What are Retirement Assets? Individual Retirement Accounts (IRAs) SEP-IRAs Simple Plans Keoghs 403(b) Plans Defined Contribution Plans Money Purchase Profit Sharing 401(k) Plans Defined Benefit Plans B. Retirement Assets Are Income in Respect to a Decedent Income in Respect to a Decedent (IRD) refers to all items of taxable income of a decedent that are not properly taxable to the decedent on his or her last or prior income tax return. 1 IRD is not entitled to a step-up basis under I.R.C As a result, IRD is always subject to income tax and may be subject to estate and generation skipping taxes. The beneficiary of the retirement asset is responsible for the income tax. 2 1 I.R.C. 691(a). 2 If the estate is subject to federal estate tax, the recipient of the IRD asset may be eligible for an offsetting income tax deduction under I.R.C. 691(c). The IRD recipient claims the IRD deduction as a Schedule A itemized deduction. 4

5 C. Required Beginning Date (RBD) A participant must begin taking required minimum distributions (RMDs) from his or her retirement account by the required beginning date (RBD). 3 The RBD is April 1 st of the calendar year AFTER the calendar year in which the beneficiary turns 70 ½. 4 Example: Bob is born on 6/30/1942 Bob turns 70 on 6/30/2012 Bob turns 70 ½ on 12/30/2012 Bob s RBD is 4/01/2013 Jane is born 7/1/1942 Jane turns 70 on 7/1/2012 Jane turns age 70 ½ on 1/1/2013 RBD is 4/1/2014 D. Required Minimum Distributions (RMDs) RMDs must begin once a participant reaches his or her RBD. RMDs are calculated based upon the Uniform Table. 5 A participant s RMD is calculated under the Uniform Table by dividing the factor into the balance of the participant s retirement account as of December 31 as of the previous calendar year. Example: In 2013, Bob will be 75 years old. The balance of his retirement account as of December 31, 2012 is $287, Bob s RMD is $12, ($287,500 divided by 22.9). 3 RMD does not apply to Roth IRA accounts. 4 For qualified plans only, RBD rules do not apply to participants who are five percent or greater owner of the business and are not retired at age 70 ½.. 5 See Exhibit A. 5

6 The only exception to the use of the Uniform Table occurs when the participant s spouse is more than ten years younger than the participant. When the spouse is more than ten years younger, the participant has the option to use the Joint Life Expectancy Table. E. Distributions at Death. To determine the RMDs to the successor beneficiary after a participant passes away, you must know the following information: 1. Did the Participant die before or after his or her RBD? 2. Are there multiple beneficiaries? 3. Does the retirement account pass to a Designated Beneficiary, and who is the designated beneficiary? The beneficiary of a retirement account must be determined by September 30 of the year following the year of the participant s death. This allows time for disclaimers to be filed, or separate accounts established for multiple beneficiaries. F. Inherited IRA -Death Before Required Beginning Date 1. Spouse as Designated Beneficiary A spouse has the option to rollover the participant s retirement account into an IRA in the spouse s name. To be eligible to rollover the IRA, the spouse must be named as the sole beneficiary of the retirement account. If the spouse elects to rollover the retirement account, the spouse can defer distributions until the spouse s RBD. The spouse can treat the IRA as an Inherited IRA account. Under this option, RMDs will be calculated based upon the spouse s life expectancy under the Single Life Expectancy Tables. Each year, the spouse is allowed to recalculate his or her RMDs under the table. To recalculate, the spouse simply finds the factor associated with his or her age. 2. Non Spouse Designated Beneficiary. Beneficiary s Life Expectancy. If the participant dies prior to the RBD, with a designated beneficiary other than the surviving spouse, RMDs will be made based upon the designated beneficiary s life expectancy using the Single Life Table. 6 To calculate the RMD, the 6 Exhibit A. 6

7 beneficiary divides the balance of the account by the factor assigned to his or her age from the Single Life Table. The beneficiary s age is determined at the participant s death. Each year, the beneficiary simply subtracts one from his or her initial factor. Example: If the beneficiary is 58 when the participant dies, the factor to determine the first RMD is 27. The following year, the beneficiary s factor to determine the RMD would be 26 (27-1). G. Inherited IRA- Death After the Required Beginning Date 1. Spouse as Designated Beneficiary As previously explained, the spouse always has the option to rollover the IRA provided the spouse is the sole designated beneficiary. If the spouse treats the IRA as an Inherited IRA, and the participant died after his or her RBD, the spouse has the option of taking distributions based upon the greater of the spouse s life expectancy under the Single Life Tables (recalculated) or the life expectancy of the participant (without the recalculation option). 2. Non Spouse Designated Beneficiary Distributions Over the Greater of the Beneficiary s or the Participant s Life Expectancy. When the participant dies after RBD with a designated beneficiary who is not the surviving spouse, RMDs are calculated based upon the greater of the beneficiary s life expectancy or the participant s life expectancy using the Single Life Tables. To determine the RMD, the beneficiary would locate the factor associated with the beneficiary s age as of the participant s date of death (or the factor assigned to the participant s age if the participant is younger than the beneficiary). Each year, the beneficiary simply subtracts one from his or her initial factor. Example: If the beneficiary is 58 when the participant dies, the factor to determine the first RMD is 27. The following year, the beneficiary s factor to determine the RMD would be 26 (27-1). If the participant was 50 when he died, the beneficiary could use a factor of 34.2 for calculating the RMDs. 7

8 The designated beneficiary must take the first distribution by December 31 of the calendar year after the year in which the participant died. If the beneficiary fails to take the first RMD by that date there will be an automatic election to default to the five-year rule. H. No Designated Beneficiary If the participant does not have a designated beneficiary and died before his or her RBD, then the retirement plan assets must be distributed under the five-year rule. 7 After the participant reaches his or her RBD with no designated beneficiary, then the retirement plan assets are distributed out over the participant s remaining life expectancy under the single life table. The following entities are not treated as designated beneficiaries: Estate Charity Non-Qualified Trust Other Entity, such as a corporation or partnership. I. Five-Year Rule Under the five year rule, all the retirement assets must be distributed to the beneficiary no later than December 31 of the calendar year five years from the participant s death. There is no requirement that the retirement assets be distributed equally over the five years. The beneficiary may wait until the fifth year to distribute the entire balance of the retirement account. J. Multiple Beneficiaries If there are multiple beneficiaries whose interests do not constitute separate accounts, then the following rules apply: 1. Unless all the beneficiaries are individuals or a qualifying trust, then the participant does not have a designated beneficiary. 2. If all the beneficiaries are individuals, or a qualifying trust, then you must use the life expectancy of the oldest designated beneficiaries for all the beneficiaries or the five-year rule applies. 7 I.R.C. 401(a)(9)(B)(ii). 8

9 The Code provides two possible ways to get around the multiple beneficiary rule: 1. Separate Accounts. If you can divide each beneficiary s share into a separate account, then each beneficiary can use their own life expectancy. The regulations reference establishing a separate account after the death of the participant 8. Therefore, a bequest of separate interests to each beneficiary will not create separate accounts. It is necessary to contact the retirement plan custodian and physically divide the account into separate shares. You should note that the separate account rule does NOT apply to multiple beneficiaries who take their interest through a trust that is named as a beneficiary of the retirement plan. 2. Disclaimer. Disclaimers will be discussed in more detail later on in Section V. K. Titling an Inherited IRA Account. For inherited IRA accounts, you should request the custodian to title the account as follows: John Doe, (Deceased) IRA fbo John Doe, Jr. John Doe, (Deceased) IRA fbo John Doe, Jr., Trustee of the Jane Doe Special Needs Trust, as created under the John Doe Living Trust Agreement, Dated May 1, John Doe, (Deceased) IRA fbo John Doe, Jr., Trustee of the Jane Doe Special Needs Trust, as created under the Last Will and Testament of John Doe, Dated May 1, You should not retitle the inherited IRA account in the name of the beneficiary. L. Clark v. Rameker 573 U.S. (2014) (No ) Heidi Heffron-Clark inherited a $300,000 individual retirement account ( IRA ) from her mother s estate. The U.S. tax code provides special rules for IRAs that are inherited by someone other than the spouse of the deceased. These rules prohibit additional contributions to the 8 Reg. Sec.1.401(a)(9)-8. 9

10 inherited account and require the beneficiary to withdraw, and pay taxes on, a minimum amount from the account each year. Heidi and her husband (the Clarks ), filed for bankruptcy in 2010 and claimed the inherited IRA was exempt from creditor claims. A bankruptcy judge ruled that retirement funds must be held for the current owner s retirement in order to qualify as an exempt retirement fund under Section 522 of the U.S. Bankruptcy Code. Because the Clarks were required to withdraw money from the inherited IRA before their retirement, the judge held that the account was subject to creditor claims in the bankruptcy proceeding. The federal district court reversed and held that Heidi s inheritance of the IRA did not change its status as a protected retirement fund. The U.S. Court of Appeals for the Seventh Circuit reversed. The United State Supreme Court held that an inherited IRA account did not qualify as a retirement fund for the purposes of exemption under the U.S. Bankruptcy Code. Since the Bankruptcy Code does not explicitly define the term retirement fund, the Court held that it should retain its ordinary meaning a fund that is set aside for an individual s retirement. Inherited IRAs do not fit this definition because the individual cannot invest more money in the account and is required to draw money from the account regardless of how far the individual is from retirement. The Court held that allowing an inherited IRA to be exempt from creditor claims would undermine the purpose of the Bankruptcy Code. III. NAMING A TRUST AS A BENEFICIARY OF A RETIREMENT ACCOUNT After the death of a participant, the remaining balance of the retirement account may be distributed over the life expectancy of the beneficiary if the participant has a Designated Beneficiary. Under the general rule, a designated beneficiary must be an individual. A trust will meet the definition of a designated beneficiary, for the minimum distribution rules, if the trust meets the following requirements: 1. The Trust must be valid under state law, or would be but for the fact that there is no corpus 9 ; 2. The trust is irrevocable or will, by its terms, become irrevocable upon the death of the participant 10 ; 9 There is no PLR, regulation, or other IRS pronouncement giving an example of a trust that would flunk this requirement. 10

11 3. The beneficiaries of the trust who are beneficiaries with respect to the trust s interest in the participant s benefit, must be identifiable from the trust instrument 11 ; and 4. Certain documentation must be provided to the plan administrator 12. A. Determination Date The date when the beneficiaries must be determined is September 30 of the calendar year that follows the calendar year of the account owner s death. Example: Sarah died on April 29, The determination date for her IRA and QRP accounts will be September 30, The minimum distributions will be computed based only on the beneficiaries who still have an interest on the determination date. If a beneficiary s interest is eliminated between the time that the account owner died and the determination date for example by a cash out or a disclaimer then that beneficiary will not have any impact on the required minimum distributions B. Conduit Trusts If the trust meets the above requirements, the beneficiaries of the trust 13 (and not the trust itself) will be treated as a designated beneficiary. 14 In other words, the IRS will look through the trust directly at the beneficiary to determine if the participant has a designated beneficiary. This type of trust is commonly referred to as a See Through Trust or a Conduit Trust. You should remember that the Separate accounts treatment and the spousal rollover options are not available to any trust, even a see-through trust. Neither the Code nor the Regulations use the term Conduit trust or See Through Trust. Both terms have been adopted as a common usage name for a trust under which the trustee has no power to accumulate retirement plan distributions in the trust. With a conduit 10 A trustee s power, after the participant s death, to amend the administrative provisions of the trust should not be considered a power to revoke. However, the IRS has never given an example of a trust that does not become irrevocable at the participant s death. 11 A designated beneficiary need not be specified by name in the plan or by the employee to the plan... so long as the individual who is to be the beneficiary is identifiable under the plan. The members of a class of beneficiaries capable of expansion or contraction will be treated as being identifiable if it is possible to identify the class member with the shortest life expectancy. Reg. Sec (a)(9)-4, A The deadline for supplying this documentation with respect to post-death distributions is October 31 of the year after the year of the participant s death. Reg. Sec (a)(9)-4, A-6(b). This deadline is one month after the beneficiary finalization date. 13 Provided all of the beneficiaries named in the trust are individuals. 14 Reg. Sec (a)(9)-4. A-5(a). 11

12 trust, the trustee is required, by the terms of the governing instrument, to distribute the RMDs to the beneficiaries of the trust on a current basis so that no amounts distributed from the qualified plan or IRA during the current beneficiaries lifetimes are accumulated for the benefit of subsequent beneficiaries. 15 The trustee has no power to hold or retain in trust any plan distribution made during the lifetime of the conduit trust beneficiary. If the designated beneficiary (or life beneficiary of the conduit trust) lives to his life expectancy, he will have received 100 percent of the benefits and the remainder beneficiary will receive nothing. 16 The IRS considers the conduit beneficiary as the sole beneficiary of the trust. All beneficiaries other than the conduit beneficiary are considered mere potential successors and are disregarded. The retirement benefits are deemed paid to the individual conduit trust beneficiary for purposes of the minimum distribution rules, and accordingly the all beneficiaries must be individuals test is satisfied. Any remainder beneficiaries are disregarded for purposes of calculating the RMDs because the IRS regards them as mere potential successors to the conduit beneficiary s interest. 17 C. Accumulation Trusts If it is necessary to qualify a beneficiary for a means tested public benefits program such as Medicaid or SSI, a conduit trust is not going to be a very workable option. If the trust requires that all RMDs are passed through to the beneficiary, you will disqualify the beneficiary from receiving means tested public benefits. To maintain the disabled beneficiary s eligibility for public benefits, the trustee must be given the power to accumulate RMDs in the trust. With an accumulation trust, you will be required to use the life expectancy of the oldest potential remainder beneficiary for purposes of calculating the RMD. This is not always a straightforward process. Under the regulations, if the first beneficiary has a right to all income for life and a second beneficiary has a right to the principal but only after the death of the first income beneficiary, both beneficiaries must be taken 15 Reg. Sec (a)(9)-5, A-7(c)(3). 16 For trust accounting purposes the Uniform Principal and Income Act requires a portion of the distribution to be set aside for the remainder beneficiaries unless the document directs otherwise. 17 Reg. Sec (a)(9)-5, A-7 (c)(3). 12

13 into account in determining the beneficiary with the shortest life expectancy as the measuring life for RMD purposes. 18 The problem is knowing when we can stop searching for remainder beneficiaries. This issue was addressed in PLR The facts in the PLR were as follows: A designated his trust as the primary beneficiary of his IRA. The terms of A s trust benefitted his spouse for her life and upon A s spouse s death, the remaining trust assets were to be divided among A s lineal descendants then living, with each descendant s share held in trust until age 30. The participant was survived by his spouse and all three living children who had already attained the age of 30. Since the spouse s share was limited to life income plus principal in the trustee s discretion, it was necessary to determine which other beneficiaries were designated beneficiaries for the RMD rules. Under the ruling, the IRS decided that we can stop searching at the child level because they will take their share outright when the prior beneficiary (the spouse) dies. If a child was under the age of 30 when the father passed away, it would be necessary to count, as trust beneficiaries, the class of beneficiaries that would inherit had the child died before the age of Additional complications may surface if the remainder interest in your trust is subject to a power of appointment upon the death of the life beneficiary. The RMD rules require that all potential appointees, as well as those who would take in default of the exercise of the power of appointment, are potentially considered as beneficiaries. Consider the following situations: 1. Power to Appoint to issue A trust that provides discretionary income and principal to beneficiary A. Upon A s death, the remaining principal and income of the trust shall be paid to such persons among the class consisting of the beneficiary s issue, as beneficiary A shall appoint by his or her will. Since A s power to appoint is limited to a clearly-defined group of identifiable younger individuals, the power of appointment does not create a problem for determining the RMDs. 2. Power to Appoint to a Charity. A trust that provides discretionary income and principal to beneficiary A. Upon A s death, the remaining principal and income 18 Reg. Sec (a)(9)-5, A-7(c). 19 See e.g., PLR ; PLR

14 of the trust shall be paid to such members of a class consisting of the beneficiary s issue and any charity as beneficiary A appoints in his or her will. Since A s power to appoint includes a power to appoint to a non-individual, the trust would not have a designated beneficiary for purposes of the RMD rules. IV. TRUSTS TRUST PLANNING CHOICES FOR BENEFICIARIES OF SPECIAL NEEDS A. Accumulation Trust There are various options available for a trust intended to provide for a beneficiary with a disability. Which type is best suited for any situation depends on whether the beneficiary needs to qualify for need-based government benefit programs and who is designated as the remainder beneficiary. A conduit trust is not suitable if the beneficiary must qualify for SSI/ Medicaid. With a conduit trust, the RMDs must be distributed to the beneficiary, and would be considered income to the beneficiary, thus jeopardizing the beneficiary s eligibility for public benefits. However, if qualification for public benefits is not an issue (for example, because the family is wealthy and intends to provide for all of the beneficiary s care), a conduit trust would be a suitable, especially if the donor wants the remainder interest to pass to a charity. To preserve public benefits, the trustee of a special needs trust must have discretion regarding the distribution trust income and principal for the benefit of the disabled individual. Generally, the trust will prohibit mandatory trust distributions for the beneficiary s needs that are provided by government programs such as support and health care. Such a trust would be considered an accumulation trust for RMD purposes. If this kind of trust is used, a charity should not be named as a remainder beneficiary. The chosen remainder beneficiaries should be (as siblings typically are) individuals close in age to (or younger than) the disabled beneficiary since the life expectancy of the oldest member of the group will be the applicable distribution period. Thus, designating a special needs trust as the beneficiary of a retirement account is less of problem if the disabled individual has living siblings who are younger or close in age. As the age gap widens with the disabled beneficiary being the youngest, the RMDs become more of a problem. 14

15 For example, a father establishes a stand alone SNT for his disabled son A and designates the SNT as the primary beneficiary of his IRA. The father s retirement account has a $250,000 balance at the time of his death. The terms of the SNT give the trustee the discretion to distribute the principal and income of the SNT for the special needs of A. Upon A s death, the balance of the assets of the SNT will go to A s siblings, B and C. A is 35, B is 38, and C is 42 on their father s death. In this case, the RMD rules require A, B, and C to be considered as beneficiaries. C s life expectancy will be used to determine the RMD because C is the oldest. However, in this case as in many cases the difference between the ages will cause a negligible difference in the RMD. The factor for C at age 42 is This means that the RMD based on C s life expectancy will be $5, ($250, ). If the RMD were to be based on A s life expectancy then it would use the factor of Therefore the RMD based on A s life expectancy would be $5, ($250, ). By naming C as a remainder beneficiary, the RMD has increased by $ The RMD increases by the difference in life expectancy between A and C, which is seven years. Although in this example the increase was $ for the year, it would be an area of concern if there was a large difference in ages between the intended beneficiary of the special needs trust and the oldest of the remainder beneficiaries. A large age gap could result in a significantly higher withdrawal. For example, let s say that A is 20 and the primary beneficiary of the SNT with a $500,000 balance. A s siblings are B who is 40 years old and C who is 45 years old on their parent s death. B and C are successor remainder beneficiaries for the SNT and thus the oldest will be used as the life expectancy for calculating the RMD. If A s life expectancy were used for the RMD, the factor would be 63. The RMD based on this factor would be $7, ($500,000 63). However, C s life expectancy will be used and that factor is That results in an RMD of $12, ($500, ). In this case, the RMD will be $4, greater because C was named as a successor beneficiary than if A s life expectancy had been used in calculating the RMD. Additionally, it is important that any provisions that are added to the trust are carefully reviewed to ensure that they will not cause a problem with regard to these rules. For example, 15

16 naming a charity as a potential remainder beneficiary will ensure that the trust does not qualify as an accumulation trust under the rules. B. Charitable Remainder Trust Planning Another option that should be considered is a lump-sum distribution of all or a portion of a taxable retirement account to a charitable remainder trust (CRT) that may first benefit the surviving spouse, then other beneficiaries (such as children), and then a charity. The principal income tax advantage is that a CRT is a tax-exempt trust, so there will be no income tax liability when it receives the income from the retirement plan account. The charitable remainder unitrust (CRUT) will commence payments to the next beneficiaries (children) upon the death of the surviving spouse. A CRUT must annually distribute at least 5% of the value of its assets, recalculated annually. The general rule concerning distributions from a charitable remainder trust (CRT) to another trust limits distributions to a term of 20 years. However, a CRT may make distributions to an individual for his or her life. Both of these general rules are a problem for persons with disabilities. A direct distribution from a CRT to an individual on SSI or Medicaid will likely cause those benefits to be lost because the distributions would create excess income or resources above means-tested program limits. But, if the CRT distributed directly to an SNT for the individual, then the payments must be limited to 20 years. The IRS addressed the issue on whether the terms of the CRT making distribution to another trust must be limited to a term of 20 years or the life of the beneficiary in Revenue Ruling Revenue Ruling provides that CRT distributions can be made to a second trust, for the life of an individual who is financially disabled under three situations. The ruling states that an individual shall be determined to be financially disabled if the individual is unable to manage his financial affairs by reason of a medically determinable physical or mental impairment which can be expected to result in death, or which has lasted or can be expected to last for a continuance period of not less than 12 months. An individual shall not be considered to have such an impairment unless proof of the existence thereof is furnished in such form and manner as the secretary may require. 22 Rev. Rul , I.R.B. 794 (Apr. 29, 2002). See Exhibit F. 16

17 The Ruling outlines three situations that allow a CRT to use the life expectancy of the beneficiary of the second trust and not a 20 year term. Each situation requires the beneficiary of the second trust to be an individual who is financially disabled. The first situation involves a CRT (Trust A) making its required payments to a support type trust (Trust B) established for the life of a beneficiary (beneficiary C). The terms of the support trust in Situation 1 are as follows: A designated portion of the amount received from Trust A will be paid to C each month. If, at any time in the sole judgment of the trustee, the monthly payment to C is insufficient to provide adequately for C s care, support and maintenance for any reason, additional amounts will be paid as needed to or on behalf of the beneficiary from Trust B. Upon C s death the balance of Trust B would be paid to C s estate. In Situation 2, a Third Party SNT receives the required payments from a CRT. Upon the beneficiary s death, the amount remaining in the SNT is required to be distributed to the beneficiary s estate. Notice that Situation 2 does not allow the balance of Trust B to be distributed to remainder beneficiaries (thereby avoiding a probate and possible estate recovery of Medicaid benefits). The third and final situation presented in Revenue Ruling involves a Self-Settled SNT. While this fact pattern is not as likely as the one with a Third Party SNT, there are circumstances in which this might be used. In this situation, a CRT makes its required payments to a Self-Settled SNT, which provides that after satisfaction of any required payback to Medicaid following the beneficiary s death, the remainder of the SNT assets pass pursuant to the beneficiary s power of appointment, or if not exercised, in equal shares to the beneficiary s sister and to a charity. There are no limits on who may be appointed to receive the remaining trust proceeds. C. Disclaimers of Retirement Benefits A disclaimer is the refusal to accept a gift or inheritance. Federal tax law recognizes that a person cannot be forced to accept a gift or inheritance. Therefore a disclaimer itself (provided it meets the requirements of 2518) is not treated as a taxable transfer. 23 For tax purposes, the person making the disclaimer never accepted the property in the first place, therefore the theory 23 I.R.C. 2518(a). 17

18 goes, he never owned it and therefore could not have given it away. For SSI/Medicaid purposes, a disclaimer will be treated as a transfer of assets. 24 Disclaimers of inherited retirement benefits can be very useful in post mortem planning even when dealing with special needs planning. However, the order of who disclaims and when will be critical. For example, you will create a period of ineligibility or be forced to create a first party pay-back trust if you named the beneficiary with a disability as your primary beneficiary and then disclaimed. Even if your contingent beneficiary was a special needs trust, a disclaimer by the disabled beneficiary to his or her special needs trust would create a period of ineligibility. On the other side of this issue, a disclaimer is an effective means to eliminate an older beneficiary, power of appointment or charitable beneficiary that impacts RMDs for the special needs beneficiary. Acceptance of required minimum distributions ( RMDs ) by the primary beneficiary of retirement accounts following the participant s death prevents the beneficiary from disclaiming both the RMDs and the income attributable to the RMDs. However, the beneficiary may validly disclaim the balance of the retirement accounts. 25 In PLR , the surviving spouse was the designated beneficiary of the decedent s IRA. The contingent beneficiaries were the marital trust under the participant s trust instrument, followed by the credit shelter trust and finally the decedent s daughters. The surviving spouse was the beneficiary of both the marital trust and the credit shelter trust and had limited testamentary powers of appointment over each. The surviving spouse sought to disclaim a fractional interest in the IRA and post-death income attributable to that interest. In addition, the surviving spouse proposed to disclaim all beneficial interests in marital trust and the limited power of appointment over the credit shelter trust. The IRS ruled that the surviving spouse could make a qualified disclaimer with respect to the limited power of appointment over the credit shelter trust, even though the surviving spouse would retain a lifetime beneficial interest in the credit shelter trust. Additionally if your parents are unsure of the extent the beneficiary will need to access needs based public benefits, a customized beneficiary designation form that allows the surviving 24 POMS PLR (November 9, 2012); PLR (June 24, 2011). 18

19 spouse to disclaim to a third party snt is an effective means to take a second look at the situation upon the death of the first spouse. 26 If disclaimers will be used, you must strictly follow the rules. Unfortunately, not every refusal to accept an inheritance is a qualified disclaimer, entitled to the blessings of The following are the requirements for a qualified disclaimer under 2518: 1. The disclaimer must be irrevocable, unqualified (unconditional), and in writing. 27 Verbal, revocable, and conditional disclaimers are not qualified disclaimers. 2. The disclaimant must not have accepted the interest disclaimed or any of its benefits The disclaimer must be delivered by a certain deadline. For retirement plan death benefits, the deadline is normally nine months after the participant s date of death. 4. The disclaimer must be delivered to the correct party(ies). 5. The property must pass, as a result of the disclaimer, to someone other than the disclaimant. 6. The property must pass, as a result of the disclaimer, to whoever it passes to without any direction on the part of the disclaimant. Disclaimers in favor of the spouse are NOT excepted from this rule. 29 However, if there is an express or implied agreement that the disclaimed interest in property is to be given or bequeathed to a person specified by the disclaimant, the disclaimant will be treated as directing the transfer of the property interest A disclaimer can be qualified under 2518 even if it is not valid under state law. 31 The income tax effects of a qualified disclaimer that is not valid under state law are uncertain. 26 Exhibit D - Sample Beneficiary Designation Form. 27 I.R.C. 2518(b). 28 I.R.C. 2518(b)(3). 29 Treas. Reg (e)(4); 2(e)(5). 30 Treas. Reg (e)(1). 31 I.R.C. 2518(c)(3). 19

20 D. Decanting Decanting may be an option to remove an older beneficiary or a nondesignated beneficiary provided the impermisible or problem beneficiaries are removed by the September 30 th deadline. Currently, there are no rulings by the IRS on whether decanting is an effective means to correct an existing trust with older or nondesignated beneficiaries. Additionally, it is unclear whether a state Medicaid office would take the position that a decanting of an existing third party snt constitutes an a transfer without consideration by the snt beneficiary. E. Reformation Private Letter Rulings have discussed a court s modification of a trust or beneficiary designation made by the settlor of a trust or the IRA owner with varying results, depending on the specific facts of the case. In PLR , the IRS refused to recognize a retroactive beneficiary designation made by the court when the decedent failed to name a contingent beneficiary (although there was no disagreement that the decedent intended to name one) after a new IRA custodian began administering the IRA. In other limited circumstances, such as in PLR , the IRS has not taken issue with court orders modifying designations. For example, the IRS respected the court order in PLR , which corrected an IRA administrator s failure to implement the decedent s instructions for naming beneficiaries. In Private Letter Ruling , the IRS refused to respect the retroactive reformation of a testamentary trust ordered by State Court for the purposes of complying with the designated beneficiary rule in the Treasury Regulations. 33 The facts are as follows: children of a decedent couple created a joint revocable trust. Upon their death, the trust was to divide into protective trusts created for their children. The terms of the protective trust provided that a beneficiary could appoint the trust assets to certain people and entities. This special power of appointment could have been exercised during the beneficiary s lifetime after a certain age or upon death. The Trustees realized that there was a problem...the trust document clearly reflected the grantors intent that the trust qualify as a see-through trust, thus avoiding the requirement that distribution of an IRA must be within five years and instead, using the life expectancy of the 32 Priv. Ltr. Rul (May 28, 2010) (a)(9)-4. 20

21 oldest beneficiary to calculate the required minimum distributions from the IRA. The applicable regulations provide that to qualify, (1) the trust must be valid under state law; (2) the trust must become irrevocable upon the death of the participant; (3) the beneficiaries of the trust must be identifiable from the trust instrument; and (4) the trust documents must be timely provided to the plan administrator. The terms to the trust clearly violated the identifiable beneficiary requirement. The same year as the surviving spouse died, the Trustees sought and obtained an order from the State Court to modifying the trust to provide, among other things, that decedents of the decedent couple born before 1955, contingent beneficiaries, and charities could not be named as potential appointees of a beneficiary s lifetime power of appointment. Despite the court order, the IRS refused to give effect to the retroactive reformation because charities were potential contingent beneficiaries of the trust and only individuals can be designated beneficiaries for the purposes of satisfying 401(a)(9). The IRS reasoned that generally, the reformation of a trust instrument is not effective to change the tax consequences of a completed transaction. The IRS s interpretation in this PLR appears to be at odds with earlier PLRs where the IRS respected a trust reformed after the IRA owner s death to qualify as a designated beneficiary, in part because of the regulation that permits the beneficiary of an IRA to be determined by September 30 of the year following death (which would also have been applicable in this case). V. FIRST PARTY (D)(4)(A) TRUSTS AND INHERITED IRAS A. Private Letter Ruling This Private Letter Ruling was brought about when Taxpayer A died while owning an Individual Retirement Account (IRA). This IRA named his four sons as beneficiaries through a beneficiary designation. One of his sons was a minor and receiving Medicaid benefits. However, if he received the money from the IRA distribution he would lose his Medicaid eligibility. 34 Exhibit E. 21

22 The share for each of the son s brothers was set aside in sub-ira accounts for their benefit. The son s share was not distributed from the IRA. However, the required minimum distributions were made to his guardian on his behalf. The disabled son s mother was his legal guardian. She sought and obtained an order from the State Court authorizing the creation of a special needs trust for her son s benefit. The trust authorized by the court was a first party special needs trust with a payback provision. This means that the son is the sole beneficiary of the trust during his lifetime and the trustee (his mother and guardian) can distribute as much principle and income she determines. However, upon the son s death, the State Department of Children and Families will receive reimbursement from the trust assets up to the amount of medical assistance that they paid on the son s behalf during his lifetime. Any remaining trust assets will then be distributed to the son s heirs at law. The son s mother executed a disclaimer as to her contingent remainder interest in the trust. To keep the son on Medicaid and fund the special needs trust with the IRA assets, the mother and legal guardian sought to transfer her son s share, as 1/4 beneficiary of his father s IRA to an IRA benefitting the special needs trust authorized by the state court. As part of this process the mother sought a private letter ruling from the Internal Revenue Service to establish two things. The first was the transfer of the father s IRA to the special needs trust would not be considered a transfer under I.R.C. 691(a)(2) and would therefore be disregarded for Federal income purposes. The second was that the mother as trustee could use her son s life expectancy to calculate the annual RMDs required under I.R.C. 401(a)(9). 1. Private Letter Ruling 1: Transfer of IRA to Trust The IRS begins the analysis of this question with an examination of whether or not the transfer from the IRA to an IRA for the benefit of the special needs trust qualifies as a taxable transfer. I.R.C. 691(a)(1) provides that all items of gross income that are not properly includible in a prior period shall be included in the gross income, for the taxable year when received, of: (A) the estate of the decedent, if the right to receive the amount is acquired by the decedent s estate from the decedent; (B) the person who, by reason of the death of the decedent, acquires the right to receive the amount, if the right to receive the amount is not acquired by the decedent s estate from the decedent; or (C) the person who acquires from the decedent the right 22

23 to receive the amount by bequest, devise, or inheritance, if the amount is received after a distribution by the decedent s estate of such right. I.R.C. 691(a)(2) goes on to state that if a right described in 691(a)(1) is received under the circumstances described in that section then the fair market value of that right shall be included in the gross income of the estate or person receiving it. For the purposes of this section, a transfer does not include the transmission at death to the estate of the decedent or a transfer to a person who has a right to receive it through bequest, devise, or inheritance. Generally, the distribution to a beneficiary of a decedent s IRA that equals the amount of the balance in the IRA at the decedent s death, less any nondeductible contributions is gross income in respect of the decedent under I.R.C. 691(a)(1) and is includible in the gross income of the beneficiary for the taxable year the distribution is received. 35 However, the rules are different when dealing with a grantor trust. I.R.C. 677(a) specifies that a grantor shall be treated as the owner of any portion of a trust whose income without the approval or consent of any adverse party is, or, in the discretion of the grantor or a nonadverse party, or both, may be (1) distributed to the grantor or the grantor s spouse; (2) held or accumulated for future distribution to the grantor or the grantor s spouse; or (3) applied to the payment of premiums on policies of insurance on the life of the grantor or the grantor s spouse. Futhermore, if a grantor is treated as the owner of a trust, the grantor is considered to be the owner of the trust assets for federal income tax purposes. 36 As such, a transfer of the grantor s assets to the trust is not recognized as a sale or disposition for federal income tax purposes. 37 Based on this analysis, the Internal Revenue Service determined that the special needs trust was a grantor trust all of which would be treated as owned by the son under I.R.C. 671 and 677(a). Therefore they determined that the transfer of the son s share of his father s IRA to the special needs trust was not a sale or disposition for the purposes of I.R.C. 691(a)(2) and was not includible for federal income tax purposes. 35 Rev. Rul , C.B Rev. Rul , C.B Id. 23

24 2. Private Letter Ruling 2: Life Expectancy for Annual Distributions The private letter ruling then moves on to analyze whose life expectancy should be used in calculating annual distributions from the IRA. The beginning point is that a trust will, in general, not be considered qualified unless the plan provides that the entire interest of each employee (i) will be distributed to such employee not later than the required beginning date, or (ii) will be distributed, beginning not later than the required beginning date, over the life of such employee or over the lives of such employee and a designated beneficiary or over a period not extending beyond the life expectancy of such employee or the life expectancy of such employee and a designated beneficiary. 38 In general, if a portion of the interest of a deceased IRA holder is payable to, or for the benefit of, a designated beneficiary, such portion will be distributed beginning not later than one year after the date of the deceased s death and distributed over the life of the beneficiary (or a period not extending beyond the life expectancy of the beneficiary). 39 The designated beneficiary is defined as any individual designated as a beneficiary by the employee. 40 The private letter ruling next examines the rules that apply if the IRA of a deceased IRA holder is divided into separate accounts for the purposes of I.R.C. 401(a)(9). 41 These rules establish that if separate accounts are established under an IRA and the beneficiaries of one account differ from the beneficiaries of another account then the accounts are not aggregated with other accounts to determine whether they satisfy I.R.C. 401(a)(9). This applies only as long as the separate accounts are established no later than the last day of the year following the calendar year of the IRA holder s death. These separate accounts must have a separate accounting maintained for each that includes all post-death investments, gains and losses, contributions and forfeitures for the period prior to the establishment of the separate accounts. 42 After analyzing these requirements, the Internal Revenue Service determined that the separate account requirements of section 1.401(a)(9)-8 of the Final regulations, Q&As 2 had been met for the years after the father s death. Additionally, the Service determined that under the facts that the trust was intended to qualify as a special needs trust, and that the Service 38 I.R.C. 401(a)(9)(A). 39 I.R.C. 401(a)(9)(B)(iii). 40 I.R.C. 401(a)(9)(E). 41 See I.R.B. 1082, 1098 (June 28, 2004). 42 Final Regulations 1.401(a)(9)-8, Q&A-3. 24

25 believed that it was appropriate to calculate the annual RMDs required under I.R.C. 401(a)(9) by using the son s life expectancy. 3. Key Facts in this Case There are two sets of facts in this case that facilitated a favorable ruling by the IRS. The first of these is that the required minimum distributions were made from the IRA to the son s guardian on his behalf. These required minimum distributions must be made by certain dates as required by the IRC. If the beneficiary fails to take the first RMD by that date will be an automatic election to default to the five-year rule. The second important set of facts in this case is that the mother, as the son s guardian and trustee of the special needs trust, disclaimed her contingent remainder interest in the special needs trust. As one of the son s heirs at law she would otherwise have a contingent remainder interest under the special needs trust. However, she is also the trustee of that trust. Under the grantor trust rules, this situation may have prevented the trust from qualifying as a grantor trust because she would have been an adverse party. In this case, without the mother s disclaimer it is possible that the trust would not have qualified as a grantor trust. Without this qualification, the trustee to trustee transfer from the IRA to the trust would not have been possible. The only solution in this case would have been to liquidate the IRA, pay all the income tax, and place the remaining proceeds into the special needs trust. 4. What You should take away from Private Letter Ruling Private letter rulings cannot be cited as precedent but only as an indication of the IRS s position on the particular question. You must pay very close attention to your deadlines for making distributions and filing any disclaimers. Do not anticipate that the IRA custodian will cooperate with you. Securing the cooperation of the IRA custodian or transferring the account to a custodian that will cooperate will be important. B. Private Letter Ruling The facts of Private Letter Ruling are as follows: The terms of the trust provide that X is the sole beneficiary of the trust during X s lifetime. The trustee shall apply so 43 See Exhibit F. 25